Risk Technology Comes Up Short on Wall StreetRisk Technology Comes Up Short on Wall Street

I was interested to hear Bank of America/Merrill Lynch executive Jay Morreale talk about next-generation BI at last week's IDC Business Intelligence and Analytics Forum in New York. But when he started talking about his 20 years of experience "building risk-analysis applications and business decision-support tools" in the financial services industry, I was thinking, okay, so was he part of what went wrong on Wall Street?

I'm no financial reporter, but who isn't familiar with some of the details of what has happened to Merrill Lynch over the past year? When AIG, Bear Sterns and Lehman Brothers hit the skids last fall, Merrill fell prey to the market gyrations and was quickly ushered into the hands of Bank of America with encouragement from the Bush Administration. When Merrill later reported some $15 billion in losses, BofA shareholders were more than a little upset, leading to the ouster of CEO Ken Lewis. (Let's not even get into the claims and counter claims by Lewis and former Treasury Secretary Hank Paulson as to how that shotgun marriage came about). Long story short, it has been a big mess.So here was Morreale, formerly CTO of Merrill and now a first vice president, enterprise, credit and market risk technology at Bank of America/Merrill Lynch, talking about where BI needs to go at a technology industry forum. We all know how well risk analysis has served financial services firms of late. Nonetheless, I certainly didn't want to dismiss what he had to say for two reasons. First, he's a technology executive, so I have to assume that he had no responsibility for the actual financial decisions that controlled the company's fate (not that he made this case or assigned blame to anyone). As I put it in this article, Morreale's job was to provide the dials, gauges and alerts; the business leaders scanned the dashboards and decided how to drive the company. Second, few firms emerged from last fall's blood bath unscathed, so there's no way to hang it on one firm (even AIG) let alone one executive.

When Morreale took questions at the end of his talk, I asked him point blank: "All the major banks and brokerage firms had risk models and decision-support technologies; so what confidence can we have in their proper use in the future given the mess we've all lived through?"

Here's his response: The models themselves are only as good as the [market] assumptions that go into them. With encouragement from the Fed, firms are now looking at more than just the numbers coming out of the models. They are looking at macroeconomic assumptions and worst-case scenarios in the financial marketplace. This is what the good firms have done all along; they looked at macro-level risks and the correlations among different risks in different organizations. They have come up with holistic scenarios of what, say, an unemployment rate of 10 percent might mean to mortgage defaults, credit card defaults and other lines of business. This type of thinking at the top of the house -- scenario analysis of macro-level events -- is what we need, and it is coming about.

The changes are "unfortunately" being driven by regulation, Morreale said, "but the firms that have fared the best have looked at these types of risks… whereas the firms that have looked at risk in pockets -- without considering the correlations among risks -- are suffering the most." (I later asked him to name standout firms on either side of that coin, but his only response was "follow the TARP," referring to the Troubled Asset Relief Program.)

I guess it is unfortunate that regulation is required, but as I detailed in this post about "The Technology Behind Wall Street's Meltdown," risk technology has all too often been used to maximize profits by minimizing reserves. Indeed, technology can do anything we ask it to do, but I have no confidence that business leaders won't lapse back into bad habits once market stability returns.

Fear and greed rule Wall Street, as it is said, but until last year's sad chapter on the meltdown there was no fear. Maybe that's a consequence of "too-big-to-fail" thinking and confidence that TARP-style Government bailouts would emerge. But rather than trust market forces and corporate self interest, I'm inclined to agree that more regulation and oversight are required if we are to prevent naked greed from once again destabilizing the global economy.I was interested to hear Bank of America/Merrill Lynch executive Jay Morreale talk about next-generation BI last week... But when he started talking about his 20 years of experience building risk-analysis applications in the financial services industry, I was thinking, okay, so was he part of what went wrong on Wall Street?